The S&P 500 (^GSPC 1.16%) has declined nearly 19% from the record high it reached mere weeks ago. That abrupt downturn was caused by the radical shift in U.S. trade policy under President Trump, especially the "reciprocal tariffs" announced on April 2.
However, the stock market recently sounded an alarm not seen since March 2009, which was the height of the Great Recession. And history says the alarm could be good news for investors. Here are the important details.
SNPINDEX: ^GSPC
Key Data Points
History says the U.S. stock market could rocket higher in the next year
Since 1987, the American Association of Individual Investors (AAII) has conducted weekly surveys that measure market sentiment. The participants are asked a simple question: Do you feel the direction of the stock market over the next six months will be up (bullish), no change (neutral), or down (bearish)? The results are published every Thursday.
On April 3, bearish sentiment measured 61.9%, the worst reading since 70.3% on March 5, 2009, the week before the S&P 500 hit bottom during the Great Recession. That sounds alarming, but bearish sentiment is viewed as a contrarian indicator because the market tends to perform well following periods of extreme pessimism. Indeed, the S&P 500 returned 67% during the year following the bearish sentiment reading of 70.3% in March 2009.
Additionally, bearish sentiment has only exceeded 60% in eight weekly surveys since July 1987, which is less than 0.5% of the time. The S&P 500 has always moved higher over the next year, returning an average of 27%. We can apply that data to current situation to make an educated guess about what the future might hold.
Specifically, the S&P 500 closed at 5,397 on April 3, the day the AAII published results from its latest weekly survey. The index will advance 27% to 6,854 over the next 12 months if its performance matches the historical average. That implies 36% upside from its current level of 5,015.
However, investors should bear in mind every situation is unique, and past performance is no guarantee of future results. How the U.S. stock market actually performs in the next year depends on macroeconomic fundamentals and corporate earnings, and tariffs could cause trouble in both areas.
Image source: Getty Images.
Some experts say Trump's tariffs could have a catastrophic impact on the U.S. economy
Tariffs increase inflation and slow economic growth. But the market is also worried about President Trump's tariffs because they were calculated based on trade deficits rather than the tariffs other countries charge on U.S. exports. Put differently, if the administration actually wanted to impose reciprocal tariffs -- meaning a like-for-like response -- the math is incorrect.
These foreign tariff rates come from the World Trade Organization, and the U.S. tariffs rates come from the White House:
- China charges a weighted average tariff of 3% on U.S. exports, but the U.S. will now charge 54% on Chinese exports.
- The European Union charges a weighted average tariff of 3% on U.S. exports, but the U.S. will now charge 20% on European exports.
- India charges a weighted average tariff of 7.7% on U.S. exports, but the U.S. will now charge 52% on Indian exports.
- Japan charges a weighted average tariff of 2.7% on U.S. exports, but the U.S. will now charge 24% on Japanese exports.
- Vietnam charges a weighted average tariff rate of 5.1% on U.S. exports, but the U.S. will now charge 46% on Vietnamese exports.
Importantly, Morningstar estimates the tariffs imposed by the Trump administration will raise the average tax on U.S. imports to 25.5%, the highest level in more than 100 years. Economist Preston Caldwell wrote, "If the tariff hikes are maintained, they will permanently reduce U.S. real GDP, and hence real living standards for the average American."
Similarly, JPMorgan Chase CEO Jamie Dimon recently warned that the tariffs would worsen inflation and slow economic growth. JPMorgan now expects the U.S. economy to slip into a recession this year. In that scenario, the stock market could fall much further. The S&P 500 has dropped by an average of 31% in past recessions.
What does it all mean to investors?
Extreme bearish sentiment has frequently preceded strong returns in the U.S. stock market. But every situation is different, and the tariffs imposed by President Trump are unlike anything seen in the past century. That leaves room for the stock market to keep falling in the weeks and months ahead.
However, investors should bear in mind this fact: The S&P 500 has recovered from every past drawdown, and there is no reason to expect a different outcome this time. In all likelihood, the current situation will be viewed as an excellent buying opportunity in hindsight. But investors should focus on high-conviction stocks and put money into the market slowly.
